Free Online WACC Calculator – Instantly Calculate Weighted Average Cost of Capital
WACC Calculator
WACC Calculator
Quickly calculate your Weighted Average Cost of Capital (WACC).
What is WACC
If you're thinking about starting your own business or are already running one, you know that money is essential for growth. Whether you need funds to replace machinery, expand your factory, open a new location, or bring in new products, capital is key. To raise this capital, you have a few options: you can invest your own money, bring in investors, or take out a loan from the bank. However, every form of funding comes with its own cost.
For instance, if you decide to invest your own money into the business, you're forgoing other opportunities like investing in mutual funds, putting money in a fixed deposit, or even just letting it sit in the bank where it would earn interest. This lost opportunity is a form of cost. Similarly, loans from banks and funds raised from investors also come with their own costs—such as interest payments or equity dilution.
When we combine all of these costs, we arrive at what’s called the Weighted Average Cost of Capital (WACC). WACC is a crucial metric that helps businesses understand the overall cost of financing their operations, whether through debt, equity, or a combination of both.
In this post, we’ll dive deeper into what WACC is, how it’s calculated, where it’s used, and explore real-life examples. We’ll also break down its equation, discuss its advantages and disadvantages, and explain why it matters for your business's financial health. Stay tuned to get a better grasp of how WACC can impact your decision-making and growth strategies!
First, What is the "Cost of Capital"?
Before diving into WACC (Weighted Average Cost of Capital), it's important to first understand the concept of the "cost of capital." But what does it actually mean? Essentially, it refers to the cost of all the funds a business uses to finance its activities.
Imagine a company wants to start a new project, replace outdated equipment, or expand its operations. To make this happen, the company will need to raise funds. These funds will come from two main sources: equity funds and debt funds.
Equity funds are raised through shareholder investments. This could be in the form of share capital, where regular shareholders contribute, or through preferred shareholders, who invest in exchange for a fixed dividend. Another source of equity funds is the company’s reserves and surplus. If the business has been operating for several years and has earned profits, those accumulated earnings can be reinvested for further expansion.
On the other hand, debt funds are borrowed money. A company can take out loans from banks or issue bonds, offering a fixed return to investors. This means that the company is committed to paying interest on any borrowed capital.
Now, both equity and debt have associated costs. The cost of debt is straightforward: it’s the interest the company pays on loans or the bond yield it offers to investors.
The cost of equity, however, is a bit more complex. It represents the expected return that equity investors anticipate for the risk they take by investing in the company. For example, if the share price increases from $100 to $120, the expected return is 20%—that 20% is considered the cost of equity.
In summary, whether a company funds itself through equity or debt, each comes with a certain cost. Understanding these costs is key to determining how efficiently the company is financing its growth and operations.
A Simple WACC Example
Imagine a business needs to raise $1 million in capital. It has three financing options:
Option 1: Borrow the entire amount through a loan at an interest rate of 12%. In this case, the cost of capital is simply 12%.
Option 2: Raise the full $1 million by issuing equity to shareholders who expect a return of 20%. Here, the cost of capital becomes 20%.
Option 3: Use a balanced approach—50% from debt and 50% from equity. In this case, the cost of capital is calculated as:
Cost of Capital = (Debt % × Interest Rate) + (Equity % × Expected Return)
= (50% × 12%) + (50% × 20%)
= (0.5 × 12%) + (0.5 × 20%)
= 6% + 10% = 16%
This 16% is referred to as the Weighted Average Cost of Capital, commonly known as WACC.
This blended strategy reduces the overall cost of capital compared to pure equity financing.
Why Not Just Use 100% Cheap Debt? (The Risk vs. Cost Balance)
Let’s say the cost of debt is 12%. That naturally raises the question: why don’t we just fund everything using the cheapest money available? On the surface, it seems like a no-brainer—debt is cheaper than equity. In fact, the hierarchy typically looks like this:
Cost of Debt < WACC < Cost of Equity
However, relying entirely on debt isn't without consequences. While debt may be the cheapest form of capital, it also comes with a significant downside: solvency risk. If your business hits a rough patch, you’re still obligated to pay that 12% interest, no matter what. In contrast, equity investors understand that their returns are variable—they might expect a 20% return, but they also know it isn’t guaranteed.
That’s why companies aim for a balanced capital structure. By combining debt and equity, they can optimize their funding to keep the cost of capital manageable while controlling financial risk. This balance is captured in the Weighted Average Cost of Capital (WACC), which represents the average cost of financing a company, taking into account both risk and return.
How to Calculate WACC (A Step-by-Step Example)
Let’s say we need a total investment of $1,000K to fund our business. This capital comes from four sources:
$350K from shareholder equity (e)
$150K from preferred shares (p)
$300K from loans (d)
$200K from bonds (b)
To understand each source's contribution, we calculate their respective weights (W) by dividing each amount by the total capital:
Weight of equity (We) = 350K / 1000K = 0.35
Weight of preferred shares (Wp) = 150K / 1000K = 0.15
Weight of loans (Wd) = 300K / 1000K = 0.30
Weight of bonds (Wb) = 200K / 1000K = 0.20
Next, we assign the cost of capital (R) for each source:
Cost of equity (Re) = 20%
Cost of preferred shares (Rp) = 15%
Cost of loans (Rd) = 12%
Cost of bonds (Rb) = 11%
Now, to find the weighted cost of capital for each source, we multiply each weight by its respective cost:
We × Re = 0.35 × 20% = 7.00%
Wp × Rp = 0.15 × 15% = 2.25%
Wd × Rd = 0.30 × 12% = 3.60%
Wb × Rb = 0.20 × 11% = 2.20%
Before we plug these into the WACC formula, there's an important adjustment: interest on debt (loans and bonds) is tax-deductible. This means we get a tax shield on the cost of debt, which we account for by multiplying the debt components by (1 - T), where T is the tax rate. Let’s assume a tax rate of 30% (i.e., T = 0.30).
Now, using the WACC formula:
WACC = (We × Re) + (Wp × Rp) + (Wd × Rd × (1 - T)) + (Wb × Rb × (1 - T))
Substituting the values:
WACC = 7% + 2.25% + 3.6% × (1 - 0.30) + 2.2% × (1 - 0.30)
WACC = 7% + 2.25% + 2.52% + 1.54% = 13.31%
Conclusion:
Your business's Weighted Average Cost of Capital (WACC) is 13.31%. This figure represents the average rate you must pay to finance your assets from all sources, adjusted for the tax benefit of debt.
How Businesses Use WACC (Making Key Decisions)
1. Capital Costs and Risk Hierarchy
• Cost of Equity > WACC > Cost of Debt
• Equity is the most expensive because it carries the highest risk for investors.
• WACC (Weighted Average Cost of Capital) reflects the blended cost of equity and debt—moderate risk.
• Debt is the least costly since lenders assume lower risk compared to equity investors.
2. Healthy Debt-to-Equity (D/E) Ratio
• A higher equity proportion (E) increases the cost of capital due to higher return expectations.
• A higher debt proportion (D) raises solvency risk and potential default.
• An ideal D/E ratio is less than 1, balancing financial stability and cost efficiency.
3. Financial Decision-Making: Should a Company Take on a Project?
• Yes, if NPV (Net Present Value) > 0 when discounted at the WACC.
• Also, if IRR (Internal Rate of Return) > WACC, the project is expected to generate value above the cost of capital.
About the Author: Abhishek Lohar
B.Com Graduate and the Founder of Free Online Financial Calculator. I specialize in simplifying complex financial calculations and investment strategies. My mission is to ensure you can make confident financial decisions using our research-backed content and accurate calculators.
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Disclaimer: The information provided in this article is for educational purposes only and should not be considered financial advice. Please consult with a qualified professional before making any investment decisions.